Petrodollar became the essential basis for the US economic hegemony in the 1970s
(Continued read Part I of the article here)
A petrodollar is a dollar earned by a country through the sale of oil. In 1972-74 the US government concluded a series of agreements with Saudi Arabia, known as the U.S.-Saudi Arabian Joint Economic Commission, to provide technical support and military assistance to the power of the House of Saud in exchange for accepting only US dollars for its oil. This understanding, much of it never publicised and little understood by public, provided Saudi ruling family the security it craved in a dangerous neighbourhood while assuring the US a reliable and very important ally in OPEC. Saudi Arabia has been the largest oil producer and the leader of OPEC. It is also the only member of the cartel that does not have an allotted production quota. It is the 'swing producer', meaning that it can increase or decrease oil production to bring oil draught or glut in the world market. As a result of this situation, Saudi Arabia practically determines oil prices. Soon after the agreement with Saudi government, an OPEC agreement accepted this, and since then all oil has been traded in US dollars. Hence the oil standard became the dollar standard.
Now why would this matter so much?
Oil is not just the most important commodity traded internationally. It is the key industrial mineral, without which no modern economy works. If you don't have oil, you have to buy it, and if you want to buy it on the world markets, you commonly have to purchase it with dollars. Other countries buy and hold dollars like they buy and hold gold because they cannot purchase oil without dollars. In 2002, a former US ambassador to Saudi Arabia told a committee of the US Congress: 'One of the major things the Saudis have historically done, in part out of friendship with the US, is to insist that oil continues to be priced in dollars. Therefore the US Treasury can print money and buy oil, which is an advantage no other country has.'
This system of the US dollar acting as global reserve currency in oil trade keeps the demand for the dollar 'artificial' high. This enables the US to carry out printing dollars at the price of next to nothing to fund increased military spending and consumer spending on imports. There is no theoretical limit to the amount of dollars that can be printed. As long as the US has no serious challengers and the other states have confidence in the US dollar the system functions.
This has been the situation and the essential basis for the US economic hegemony since the 1970s. Needless to say, this system enables the US administration to effectively control the world oil market.
The petrodollar is one of the key foundations of the modern world economy that inescapably filters through geopolitics. While this has produced undeniable benefits for the US political and economic elites, it has left the US economy intimately tied to the dollar's role as global reserve currency.
In this situation, dollars rapidly accumulated in foreign banks, particularly those serving petroleum-exporting countries. These petrodollars created an additional financial issue, because unlike Western Europe and Japan most of the oil-exporting countries had limited possibilities for domestic development and consumption. The Nixon administration responded by coaxing these countries into buying up US Treasury bills and bonds, which has since that time been the primary strategy for the US administration to deal with its colossal trade deficits. For the oil exporters investing these petrodollars straight back into the US economy has been possible at zero currency risk. "So long as OPEC oil was priced in U.S. dollars, and so long as OPEC invested the dollars in U.S. government instruments, the U.S. government enjoyed a double loan. The first part of the loan was for oil. The government could print dollars to pay for oil, and the American economy did not have to produce goods and services in exchange for the oil until OPEC used the dollars for goods and services. Obviously, the strategy could not work if dollars were not a means of exchange for oil. The second part of the loan was from all other economies that had to pay dollars for oil but could not print currency. Those economies had to trade their goods and services for dollars in order to pay OPEC". (David E. Spiro, The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets, Ithaca: Cornell UP, 1999, p. 121)
For a long time everything worked smoothly. But the end of the Soviet bloc and the emergence of a new single Europe and the European Monetary Union in the early 1990s began to present a completely new challenge to the global position of the US power. Especially with the creation of the euro in late 1999, an entirely novel element was added to the global financial system. 'The introduction of the euro is the most important event for the global financial markets since the United States abandoned the gold backing for the dollar in 1971'. In just a few years after this, the euro has emerged as a real alternative, establishing itself as the second most important currency in the world's financial markets.